Whether this is good or bad is subjective. Among investors, your answer will probably depend on how you are positioned. Points of Return discussed the S&P 500’s top-heavy concentration last Wednesday, and concluded that narrowness isn’t necessarily all that bad. In fact, history shows that equity upside has typically come from a narrow set of companies. Further, once the relative performance of these big gainers has subsided, the broader market has historically held up just fine — with gains outnumbering losses.
So now that the rally has topped 20%, is it a new bull market or simply a rally within an ongoing bear market? Pundits on either sides will be able to make their cases — and make them well. So here we attempt to break the arguments down for you.
The Case for a Bull Market:
1) The Traditional Definition
Going by the most famous — though irrational — definition, a bull market can be declared if the benchmark index has risen 20% or more from its recent trough. It’s an arbitrary cutoff, and in practice it’s not helpful. It’s true that the S&P 500 on Monday extended a rally that placed the gauge on the cusp of that bull-market milestone, at one point in the session jumping 20% from its October low.
But what difference does it make? This chart, from the terminal, shows all the discernible moves of 20% or more in either direction since the Great Crash of 1929. There are a lot of them. There really isn’t much need to endow the 20% mark with anything particularly significant. There are obvious, much longer trends undergirding the market, and they tend to involve moves much greater than 20%:
2) It’s Been a While
Roughly 236 days by our count to be exact. It would be very, very unusual for the stock market to go back to its low after levitating above it this long. The nadir of this cycle was Oct. 12 at 3,577.03, before the gauge rallied upward. Back then, Bloomberg’s Jan-Patrick Barnert reported that the average number of trading days until the S&P 500 bottoms is 318. While there have been longer stretches (like 761 days in 1946 and 678 days in 1929), there have been much shorter ones too (including 23 days in 2020, and 62 days in 1990). So if October really was the bottom, it’s surprising that the bear market ended when it did, after just 195 days:
But it’s also unusual for a recovery to last this long without revisiting its low and not go on to endure for the longer term. Todd Sohn of Strategas Research Partners points out that the S&P 500 broke a 12-month streak of negative year-over-year returns in April. It’s unusual for negative returns to persist so long, and historically, the market has been up a year after breaking the streak every time that’s happened. Returns over such a period vary from from 2% to 38%, but as Sohn says, “at the very least, it would suggest that maybe the worst is behind us.”
3) Volatility Is Quite Nonexistent
The relative calm in the CBOE Volatility Index, which plummeted to a two-year-low last Friday, is somewhat of a head-scratcher. Also known as the “fear index,” the VIX is a gauge of options cost tied to the S&P 500. It typically pivots higher in times of turmoil. That it has barely reacted to the sharp market gyrations in the past months is confounding.
“Multi-year lows in the VIX tend to occur in bull markets, not bear markets,” said SentimenTrader’s Dean Christians. “Except for August 2000, every two-year low in the VIX occurred in a bull phase, leading to an upward bias in stocks.” Note that the two extreme lows for the VIX this century both came just as the market was about to take a tumble, but the index needs to fall much further before reaching that point.
4) What Earnings Recession?
Wall Street was bracing for a horrible earnings cycle, but so far, it has been good. In fact, forecasts for the S&P 500 have been revised higher (and even more so in Europe), implying that prospects for corporate profit growth look better than many realized — and also, crucially, much better than many had believed at the nadir in October. Can that really be achieved? Evidence of such an outcome can be found in resilient sales, lower transportation and energy costs as well as a weakening dollar. And because all these combined are raising analysts’ earnings expectations, they are also revealing some notable entry points for investors, according to JPMorgan Private Bank’s 2023 mid-year outlook published Monday.
To be sure, some like Morgan Stanley’s Mike Wilson, one of Wall Street’s biggest bears after accurately predicting the 2022 selloff, still think there could be a meaningful earnings recession this year (a roughly 16% decline) that has yet to be priced in. This, he wrote Monday, will be followed by a sharp EPS rebound in 2024/2025.
5) Bearish Sentiment Writ Large
If there is anything consistent this year, it is the pessimism. Look no further than the spread in the American Association of Individual Investors’ weekly survey between those describing themselves as bulls and bears. Negative sentiment spiked to an extreme last fall, just before the low. That was the most bearish the survey had been since early March 2009 — which arrived exactly in time for the low after the Global Financial Crisis. Clearly then, the negativity (which also shows up in surveys of fund managers, most famously run by Bank of America Corp.) is strong enough to offer respectable argument that this is indeed a new bull market. Generally, bull markets can only take off once all hope is lost, and every last dash of speculative excess has been cleaned from the markets. It’s just possible that happened last October:
The Case for a Bear Market Rally:
Bull markets start when stocks are cheap. Market valuation currently is far too high for this. The graph below marks all previous bear-market bottoms from the post-First World War 1920s through 2009’s post-GFC crisis and beyond going by the CAPE, or the cyclically adjusted price-to-earnings ratio concept popularized by Yale University Professor Robert Shiller. For the uninitiated, it’s also known as the Shiller P/E ratio, and is based on the average inflation-adjusted earnings from the previous 10 years, not just from the previous 12 months.
It’s not useful for timing — many on Wall Street missed the 2009 bottom because they thought CAPE would fall further — but it’s a brilliant predictor of longer-term returns. Last October looks nothing like previous market bottoms.
Alternatively, use the CAPE yield, the inverse of the CAPE. The higher the yield, the cheaper stocks are. The graph below charts it with the 10-year bond yield. Turning points tend to come when the two asset classes are out of sync. The last bull market in 2009 commenced with stocks way cheaper than bonds, while the 2000 bear market started with stocks wildly more expensive. That pattern is not remotely on display today.
It has been said by dozens of strategists. The breadth of this market is just too narrow. How narrow? The graph below compares the present combined weighting of the top 10 largest stocks by market cap in the FT Wilshire 5000 Index, which effectively represents the entire US equity market, with the same figures for 10 years ago, and 23 years ago during the dot-com bubble. Even in 2000, the weighting of the top 10 at 20.3% was much lighter than today, when they account for almost 26%.
What’s more interesting are the returns these heavyweights post. In the past, the top 10’s weighted returns (the darker bars on the right) were trumped by the overall market (gray bars). Not this time. To Philip Lawlor, managing director of market research at Wilshire Indexes, so “enormous” is the the current concentration impact that “not only are we seeing a greater concentration, but we are also seeing more dependence on the return contribution.”
Put differently, there has seldom or never been less reward for taking the risk of investing in stocks outside the biggest mega-caps. More signs that this rally may not have legs by looking “under the hood” are in this data compiled by Bloomberg, which shows more stocks made new 52-week lows in the S&P 500 than 52-week highs in May. In bull markets, optimism prevails and tends to raise all boats. That’s not happening now.
Indeed, the popularity of the mega caps reflects continued lack of confidence. Kristen Bitterly, Citi Global Wealth Management’s head of North America Investments, pointed to their strong cash flows and profits at a time of tightening credit conditions and economic uncertainty, and summarized investors’ argument for holding them as: “If I’m going to put money into the market, where do I want to be? Well, in those companies that are showing strong results and have the cash flow to actually fund future growth and innovation.” If there were greater confidence over the economy, investors would be more excited to look for bargains, and the market would be broader.
We have been braced for what is accurately known as the most-anticipated recession in US history for more than a year now, yet consensus dictates the economy hasn’t yet entered one. Saira Malik, chief investment officer at Nuveen, for one, wrote in a Monday note that she expects a mild recession sometime in 2024 as the “growth-dampening effects of tight monetary policy work their way through the economy.”
Recessions have a simple effect on bull markets. The latter can’t start until the economy has entered the former. Using the Dow Jones Industrial Average, which is a flawed index but does give a fairly accurate representation of the US stock market back into the 19th century, we find that the sole exception to this maxim came in the bull market that started in 1942. As the war effort cranked into full speed, the economy had just sustained an even bigger shock than it suffered many years later from Covid-19.
A related point is that the stock market tends to wait until the Fed has started cutting rates (in other words, when a recession is either imminent or has already started) before making a low. If this really is a new bull market, it’s the first to start when the Fed is still hiking:
If a recession has only been delayed, it would be very strange if the low for the stock market were already in. If a downturn can be avoided altogether, maybe last year’s selloff can be classified as an extreme response to speculative excess, like the Black Monday Crash of 1987. But it’s a stretch. It’s very odd for a bull market to start at this point in the economic cycle.
4) It’s So Overbought
Market technicians complain that the market looks overbought, which suggests that there is some froth at present. That calls into question how much we should trust the positive signal being sent by the 20% rise from the trough. On Friday, when the benchmark gauge scaled new 2023 highs, it also closed at its most overbought level since July 2021. Bespoke Investment Group’s graph below shows the S&P 500 closing 2.47 standard deviations above its 50-day moving average to fall into the “extreme category.”
That’s only a short-term indicator, but it’s notable that every time the stock market has rushed this far ahead of itself since the bear market started, a selloff has followed.
With hindsight, it’s conceivable that we’ll say that we’re already in a secular bull phase. Whether the market goes through the low or not, these are historically strange times. But the clearest message is that nobody should assume that US stocks will rise in a straight line from here, just because they’ve gained 20% from their low.
Time for more adventures on Substack (and LinkedIn). There are some great newsletters out there. I’ve been directed to The Honest Broker by Ted Gioia, a newsletter on music, literature and the arts by a former Stanford academic (it looks very interesting from my first scroll through); Net Interest by Marc Rubinstein, a former hedge fund manager who writes weekly on an array of financial topics in his newsletter, and also finds time to contribute to Bloomberg Opinion; The Intrinsic Perspective by Eric Hoel, a polymath whose big aim is to bridge the world of science and the humanities; Money Inside Out by Jens Nordvig and the team of scarily bright people around him at Exante Research, capturing the big picture of global finance; and Kevin Muir’s Macro Tourist. Also, you should of course check out all the newsletters available to you at Bloomberg. There’s a handy list here, and for some of them we won’t even charge you.More From Bloomberg Opinion:
• Marcus Ashworth: BRICS Raging Against the Dollar Is an Exercise in Futility
• Allison Schrager: Dear CEOs: Please Focus on Profit, Not Politics
• Javier Blas: Saudi Arabia’s Solo Oil Production Cut Is a Risky Strategy
–With assistance from Patrick McDowell.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
John Authers is a senior editor for markets and Bloomberg Opinion columnist. A former chief markets commentator and editor of the Lex column at the Financial Times, he is author of “The Fearful Rise of Markets.”
More stories like this are available on bloomberg.com/opinion
